Lessons learned – contract renewals and exit management
August 2018 | SPECIAL REPORT: TECHNOLOGY IN BUSINESS: STRATEGY, COMPLIANCE & RISK
Financier Worldwide Magazine
August 2018 Issue
The expiry and re-bidding of outsourcing contracts provides some harsh lessons about the content of outsourcing contracts that were signed years ago. One of the main issues is about the need for information from the incumbent service provider to support a competitive re-procurement or renewal of the contract.
Although it may appear counterintuitive, it is extremely important that considerable thought is given to the position upon termination or expiry at the outset of the outsourcing contract. It is all very well having (in theory) the right to terminate an outsourcing contract for breach upon 30 days’ notice or the right to terminate at convenience upon three months’ notice. However, if, in reality, any genuine re-tendering exercise is likely to take at least six to 12 months to undertake (especially if the customer is a public or quasi-public sector body and is therefore subject to some form of compulsory competitive tender regime, such as applies in the European Community) then the customer is going to be very reliant upon the incumbent service provider for a considerable period of time.
Many customers have learned, to their cost, the need to be comprehensive and exact about the assistance they may require from an incumbent service provider on expiry or termination. It is an area where best contract practice has moved on considerably in the last three or four years.
The general obligations of support and assistance are, these days, supplemented by even longer and more exact specifications of the type and extent of assistance, information and services required.
The customer should ensure that the migration of the services from the incumbent service provider, either back to the customer or to a replacement service provider, occurs with the least possible disruption. It is important that the customer focuses on its requirements for exit at an appropriate stage in the negotiations and that the outsourcing contract sets out a clear exit strategy.
Termination or expiry
An outsourcing contract may end, for a variety of reasons, such as: (i) the expiry of the fixed term (and the parties being unable or unwilling to agree upon the terms for its renewal); (ii) termination by the customer for convenience; (iii) termination by the customer as a result of the service provider’s material breach or insolvency; (iv) termination by the service provider for the customer’s material breach, for example non-payment of fees; or (v) force majeure.
In theory, the customer’s practical requirements for the exit strategy will be the same in each of the above circumstances. In practice, the circumstances in which exit could occur need to be considered as they are likely to significantly affect the willingness of both parties to cooperate on exit, the timing of the required activities and the attitude of the parties to paying for the cost of exit.
Having considered the possible scenarios, the parties may agree general disengagement provisions to apply to all disengagement scenarios, or a range of disengagement provisions to apply to different disengagement scenarios. For example, upon the expiry of the contract, or where the contract is terminated by the service provider for the customer’s breach, the service provider could be entitled to charge its standard rates for disengagement services. By contrast, where the customer terminates the contract for the service provider’s breach, the service provider could be required to provide disengagement services at no cost to the customer.
The exit plan
The outsourcing contract should include a procedure by which the exit strategy agreed between the parties can be documented in an exit plan at a relatively early stage during the life of the outsourcing contract. Furthermore, it requires periodic review and update of the exit plan by the parties, for example it should be reviewed at least annually and at least six to 12 months prior to expiry. The customer should be aware that whatever the requirements of the outsourcing contract, the reviews of the exit plan may not always take place when planned (if at all) and may not reach an agreement. It is therefore important to put in place appropriate contract management procedures to ensure that these reviews do take place.
Some of the challenging areas to address in an exit plan are discussed below.
There may be numerous assets that need to be transferred to, or accessed by, the customer or replacement service provider on exit. When formulating an exit strategy, the types of ‘assets’ which the customer should consider include: hardware, software, intellectual property rights, third-party supply contracts and licences, and other physical items of equipment and data.
However, in many cases it is difficult or impossible to identify in detail, at a time when the outsourcing contract is being negotiated, what assets the customer or replacement service provider will require on exit. The key is to establish the process for identifying the assets at the relevant time, anticipating how they will need to be transferred (and any likely constraints on doing so) and determining how they are to be valued.
To ensure that the process of identifying and transferring assets works smoothly in practice, it is sensible, from the customer’s perspective, to require the service provider to maintain a register of assets.
The service provider may have a range of service or supply contracts in place with third parties in relation to the services, for example software licences, hardware and software maintenance contracts, telecommunications agreements and disaster recovery contracts.
The exit strategy needs to include a mechanism to: (i) identify the contracts the customer wishes or needs to take over on exit, bearing in mind that some or all of these contracts may not be specific to the customer but may be applicable to the service provider’s customers generally; (ii) identify how those contracts should be transferred, for example whether they can be assigned or novated; (iii) reconcile any payments made in advance or arrears; and (iv) allocate responsibility for any actions or omissions (which could give rise to claims under the contracts concerned) taking place before or after exit.
It is useful if the outsourcing contract includes an obligation on the service provider to ensure that its agreements with third parties can be assigned to the customer or a replacement service provider without restriction and at no cost. However, the customer should be aware that in some cases the service provider may be unable to secure these arrangements with its third-party service providers or the cost of doing so may be prohibitive. Whatever the case, the customer should ensure that the service provider reverts to it on these decisions to ensure that the viability of the exit strategy is maintained.
The customer should consider what data will have to be transferred from the service provider on exit (or accessed from it after exit). This might include data actually handled or processed for the customer as part of the services, for example payroll data, data about the way the services are delivered, such as records of service level performance, or data about the personnel involved in service delivery.
The outsourcing contract should make it clear who owns the data and what rights the parties have to use and access it. The customer should focus its attention on the data genuinely needed to enable a smooth transition to the replacement service provider.
The customer should also consider how the data will be accessed or transferred. A procedure may be necessary for data handover, including detailing the format of the data to be transferred and the testing arrangements to ensure that there is no data loss or corruption, which is particularly important in the case of live, operational data. If the incumbent service provider is to retain certain data after exit, arrangements should be put in place to ensure that the relevant data is retained for the necessary periods and that appropriate rights are granted to the customer and the replacement service provider to access that data as and when necessary.
While specific disengagement requirements will depend on the nature of the contract and the parties’ preferred approaches in each case, there are a number of reasonably common disengagement procedures that may be applied.
The provisions can be broadly categorised as obligations of the service provider and rights of the customer. The obligations of the service provider include: (i) preparing a disengagement plan; (ii) continuing to perform all or part of the services as required by the customer; (iii) providing assistance and information as required by the customer to transition the project or service to a replacement service provider, for example work in progress reports, handover reports and so on; (iv) returning the customer’s property, including the customer’s intellectual property and confidential information; (v) cooperating with the customer and the customer’s other service providers; and (vi) minimising disruption to the customer in transitioning the project or service.
The rights of the customer include: (i) using the service provider’s property, including a licence to use relevant intellectual property, to complete the project or continue to perform the services; (ii) to purchase assets of the service provider used by the service provider to perform the contract; (iii) to reject any desirables provided by the service provider prior to termination and obtain a refund of the charges already paid by the customer (this is more likely to be relevant to project contracts); and (iv) to solicit the service provider’s employees involved in performance of the contract.
Before entering into an outsourcing contract the parties should consider the potential disengagement scenarios and develop appropriate tailored disengagement provisions.
Appropriately drafted disengagement provisions will assist in effecting a smooth disengagement and transition upon the expiry or termination of the contract, with parties being clear about their respective rights and obligations and with minimal disruption to the customer’s business and operations.
Dr Sam De Silva is a partner at CMS Cameron McKenna Nabarro Olswang LLP. He can be contacted on +44 (0)20 7524 6223 or by email: email@example.com.
© Financier Worldwide
Dr Sam De Silva
CMS Cameron McKenna Nabarro Olswang LLP